CHAPTER 9
LONG TERM ASSETS I:
PROPERTY, PLANT AND
EQUIPMENT
Property, Plant, and
Equipment
Represent a major
source of future
service potential
Valuation is important
because
indication of physical
resources available to
the firm
and may give some
indication of future
liquidity and funds flow.
Accounting Objectives
1 Accounting and reporting to investors on
stewardship
2 Accounting for the use and deterioration of plant
and equipment
3 Planning for new acquisitions
through budgeting
4 Supplying information for
taxing authorities
5 Supplying rate-making
information for
regulated industries
Accounting for Cost
Initial cost: sacrifice of resources given up
now to accomplish future objectives
Preferred measurement
technique: discounted present
value of future receipts
Indicates future services
potential
Accounting for Cost
Some problems
Group purchases
Self constructed assets
Removal of existing assets
Non-monetary exchange
Donated or discovery values
Group Purchases
Total acquisition cost
must be allocated to
the individual assets
Usual method:
base the allocation on
the relative fair market
values
Self Constructed Assets
What is cost?
Include all incremental costs
Allocation of fixed overhead
None
Incremental
Same basis as other products
Interest
SFAS No 34 issues
The concept of qualified assets
The amount to capitalize
Removal of Existing Assets
Charge removal cost
less proceeds to cost
of land
Assets Acquired in
Noncash Transactions
APB No. 29
Fair value for most
Book value when the exchange
is not the culmination of the
earnings process
Recording gains and losses
on similar productive assets
Recognize all losses
Recognize a proportional gain
to the extent boot is received
Donated
and Discovery Values
How they occur
Record
value as an asset
and as other
comprehensive income
Financial Analysis of Property
Plant and Equipment
The impact of PP & E on the return on
assets ratio
Sustainability of earnings
Evaluating a company’s replacement of
assets policy
Financial Analysis of Property
Plant and Equipment
PP&E Acquisitions
(As % of total assets)
23.9%
23.4%
25.00%
20.00%
15.00%
11.0%
9.4%
10.00%
5.00%
0.00%
2002
Best Buy
2003
Circuit City
Financial Analysis of Property
Plant and Equipment
Financial Analysis of Property ,
Plant and Equipment
The companies’ return on
assets percentages are not
being distorted by a failure
to systematically replace
their long-term assets
Best Buy is replacing its
assets over twice as fast
as is Circuit City
Cost Allocation
Capitalization implies future
service potential
Matching concept requires
expiration of future service potential to be
recorded in the period incurred
“cost allocation”
Actual expiration of future service
potential difficult to ascertain
method of cost allocation should be
systematic and rational
Depreciation is a form of cost allocation
The Depreciation Process
Issues:
1 Establishing the proper
depreciation base
2 Determining useful service life
3 Choosing a cost allocation
method
 Straight-line
 Accelerated
 Units of Activity
Capital Vs. Revenue
Expenditures
Whether to capitalize
or charge to expense
expenditures required for an
existing long-term asset
Criteria
Prolong life or increase efficiency Capitalize
Ordinary and necessary
Expense
Recognition and
Measurement Issues
User needs are currently not being
satisfied
Suggests a current value approach
Impairment of Value
Long-term asset accounting should be
similar to accounting for other assets
Asset should be written down when value diminishes
SFAS No.121
Impairment occurs when carrying amount is not
recoverable
Future cash flows < Book value
Recognize loss when book value is not recoverable
SFAS No. 144
Accounting for the Impairment or
Disposal of Long-Lived Assets
Issued because SFAS No. 121 did not address
accounting for a segment of a business
accounted for as a discontinued operation under
APB Opinion 30.
Consequently, two accounting models existed for
long-lived assets to be disposed of.
The Board decided to establish a single
accounting model
based on the framework established in SFAS No. 121,
for long-lived assets to be disposed of by sale.
SFAS No. 144
Accounting for the Impairment or
Disposal of Long-Lived Assets
Applies to all dispositions of
long-term assets
Excludes current assets,
intangibles and financial
instruments because they are
covered in other releases.
According to its provisions
assets are to be classified as:
1. Long-term assets held and used
2. Long-lived assets to be
disposed of other than by sale
3. Long-Lived Assets to Be
Disposed Of by Sale
SFAS No. 144
Accounting for the Impairment or
Disposal of Long-Lived Assets
Long-term assets held and used
are to be tested for impairment
using the SFAS No. 121 criteria if
events suggest there may have
been an impairment.
The impairment is to be
measured at fair value by using
the present value procedures
outlined in SFAC No. 7.
For long-term assets held and
used, it might be necessary to
review the original depreciation
policy to determine if the useful
life is still as originally estimated.
SFAS No. 144
Accounting for the Impairment or
Disposal of Long-Lived Assets
Next the assets are grouped at the lowest level
for which identifiable cash flows are
independent of cash flows from other assets
and liabilities
Losses are allocated to the assets in the group
on a pro-rata basis.
Any losses are disclosed in income
from continuing operations
SFAS No. 143
Accounting for Asset Retirement
Obligations
Objective: to provide accounting
requirements for all obligations
associated with the removal of
long-lived assets
For each asset retirement obligation
Initially record the fair value (present value) of the
liability to dispose of the asset when a reasonable
estimate of its fair value is available.
Required to use SFAC No. 7 criteria for recognition of
the liability
Present value of the asset at the credit adjusted rate.
Defined as the amount a third party with a comparable credit
standing would charge to assume the obligation.
SFAS No. 143
Accounting for Asset Retirement
Obligations
Capitalized asset retirement cost
allocated in a systematic and rational
manner as depreciation expense over
the estimated useful life of the asset.
Initial carrying value of the liability
increased each year by use of the
interest method
using the credit adjusted rate
classified as accretion expense
and not interest expense.
International Accounting
Standards
The IASC has issued
pronouncements on the
following issues:
1. The overall issues associated with accounting for property,
plant, and equipment assets in a revised IAS No. 16, "Property,
Plant and Equipment."
2. Interest capitalization in IAS No. 23, “Borrowing Costs.
3. Impairment of Assets in IAS No. 36, “Impairment of Assets.”
4. Accounting for Investments in Property in IAS No 40,
“Investment Properties.”
5. The accounting treatment for assets held for disposal in IFRS
No. 5, “Non-Current Assets Held for Sale and Discontinued
Operations.”
Property, Plant and
Equipment
IAS #16
Revised IAS No. 16 did not change the
fundamental approach to accounting for
property plant and equipment.
Recognize items as assets when economic benefit will flow to
enterprise and cost can be measured
Preference is to depreciate historical cost of assets
Allows revaluations to current market value
Requires recording of impairments
Depreciation charge should reflect pattern
of benefits
If change in pattern of benefits is noted,
change depreciation method to reflect
new pattern
Property, Plant and Equipment
The major clarifications in revised IAS No. 16:
1. Requiring a components approach for
depreciation
2. The acquisition cost of property, plant, and
equipment should include
 Amount of an IAS 37 provision for the estimated cost
IAS
of dismantling and removing the asset and restoring
the site
 Include both provisions when the asset is acquired and
incremental provisions recognized while the asset is used
#16
3. Accounting for incidental revenue (and related expenses)
during construction or development of an asset will depend on
 Whether the incidental revenue is a necessary activity in bringing
the asset to the location and
 Working condition necessary for it to be capable of operating in the
manner intended by management
Property, Plant and
Equipment
IAS #16
4.
Measurement of residual value defined:

5.
the current prices for assets of a similar age and
condition to the estimated age and condition of the
asset when it reaches the end of its useful life.
Exchanges of similar items of property, plant, and equipment


recorded at fair value
gain or loss will be recognized
 unless neither the fair value of the asset given up
nor the fair value of the asset acquired can be
measured reliably
Subsequent expenditure is capitalized
only if the expenditure increases
the asset's future economic benefits above
those reflected in its most recently assessed
level of performance
FASB Staff Review of
IAS No 16
Several differences:
1
2
3
4
Alternative treatment allowing revaluation of assets distorts
intercompany comparability
Unclear and inconsistent guidelines for determining fair value
No discussion of accounting for the extractive industries
Failure to specify rules for capitalization of subsequent
expenditures related to assets
These areas of concern were not addressed in
the revised standard
Borrowing Costs
IAS #23
Benchmark treatment: recognize
interest cost in period incurred
Alternative treatment: capitalize
avoidable interest
FASB staff review expressed
concern over ability to choose
treatments which could result in a
large impact on reported net
income
Impairment of Assets
IAS #23
Requires:
an impairment loss to be recognized on items of property, plant
and equipment
whenever the recoverable amount of an asset is less
than its book value
The recoverable amount is the higher of
asset’s selling price
or value in use (present value of future cash flows)
An impairment loss is recognized as an expense on the
income statement
FASB staff review indicated
Identification criteria similar
Approach to recognition, measurement and
reversing are dissimilar
Investment Property
IAS #40
Defined as land or buildings held to
earn rentals or for capital appreciation
May account by either:
Fair value with changes
reflected in income
Cost and depreciated
No FASB staff review
Non-Current Assets Held for Sale
and Discontinued Operations
IFRS #5
Establishes a classification for noncurrent assets 'held for sale'
using the same criteria as those
contained in US FASB Statement 144
Accounting for the Impairment or
Disposal of Long-Lived Assets.
The assets need to be disposed of
through sale.
Therefore, operations that are
expected to be wound down or
abandoned would not meet the
definition
but may be classified as discontinued
once abandoned.
Prepared by
Richard Schroeder, DBA
Kathryn Yarbrough, MBA
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